Of all the pro-taxcut arguments cropping up over recent days, the one I’ve heard most frequently is "well, the rich pay more tax than the poor, so they deserve a bigger tax cut". This argument has a superficial appeal to it, but I think it’s based on a misleading premise. Let me try to explain why.
When we talk about spending measures (eg. introducing a baby bonus, putting in place a private healthcare rebate, subsidising people to watch Big Brother), we tend to compare it with the status quo. In other words, how will this measure improve overall well-being, and how will its gains be distributed among rich and poor?
Economically, there’s no reason not to take the same approach with tax reform. The right question to ask is: "compared to the world we live in now, what impact will tax cuts have on efficiency and equity?". Those who argue that the rich should always get a bigger slice of every tax cut aren’t doing this exercise. Instead, their implicit comparison is "compared to a world in which we have zero taxes and the government doesn’t exist, what impact will the new tax scales have on efficiency and equity?".
So next time you hear someone argue that when we cut tax, more should always go to the rich, ask them whether they think that when we introduce a spending program, more should always go to the rich. Because in equity terms, giving $6.9 billion dollar Kerry Packer a $4500 tax cut is no different to the government cutting him a $4500 cheque.
* There are actually some reasonable arguments in favour of cutting top tax rates, mostly coming out of the optimal taxation literature. But when you take into account the effective marginal tax rates that arise from our highly targeted welfare system, it starts to look as though the big disincentive problems are much more likely to be at the bottom of the income distribution than at the top.